Magazine

Online Extra: Slick Plays in the Oil Patch

June 27, 2004

OPEC has finally given consumers some relief. Oil has fallen from $40 a barrel to $37 since the cartel hiked its production quotas on June 2. But few oil-industry watchers expect crude to fall back to the under-$20-a-barrel range it saw for much of the 1990s. Burned by past commodity cycles, oil companies remain tightfisted when it comes to their exploration budgets. Demand worldwide is increasing much faster than supply. And OPEC, despite its recent generosity, is showing remarkable restraint.

All of this is good news for two sorts of people: Arab sheiks and energy investors. If you find yourself in the latter category, you can still make money in these stocks. True, the prices of many already reflect the great run in crude, but a number of pros think you can keep finding good buys by looking for companies with strong management teams, good growth prospects, and internal dynamics in their favor.

For example, the oil industry has ridden a mammoth merger wave in the past five years that has led to higher returns on capital. Douglas G. Ober, manager of the $537 million Petroleum and Resources Corp. fund, thinks ConocoPhillips (COP), the product of a 2002 merger, still has a way to go. Ober credits management with doing an excellent job of handling the merger.

REENERGIZED. "The two companies separately were sort of plodding along," he says. "The combination has reenergized them and got them running their operations more efficiently." Ober notes that ConocoPhillips has significant reserves in the Far East, Africa, and the Gulf of Mexico. It's also the largest owner of refineries in the U.S.

Another way to find a bargain is to look for companies in the midst of a restructuring. That's why William Cashman, manager of the UMB Scout Energy fund likes Anadarko Petroleum (APC), a one-time high-flyer that stumbled in recent years. A new management team has refocused it, selling off underperforming assets and focusing on core areas such as Algeria and the Southwestern U.S. "Two years ago this company sold for $70 a share," Cashman says. "It's now $55. They've got great reserves, 2.5 billion barrels, tremendous cash flow, and a lot of leverage if they can get those assets out of the ground."

A.G. Edwards energy analyst L. Bruce Lanni takes a very analytical approach. He has examined the 12 largest publicly traded oil companies and compared them over a three-year period based on a number of operating and financial criteria, including their returns on capital and ability to find new reserves. Then he ranked them based on their combined scores. The winners were Total Fina Elf (TOT), BP (BP), and Occidental Petroleum (OXY). All three have two things in common: low costs for finding oil and above-average growth in their oil and gas production. Oil prices may be softening, but over the long run companies like these should sprint ahead of the pack. By Christopher Palmeri in Los Angeles